Inventory finance for small businesses explained
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For retailers, having the right stock is everything. However, you need money to buy inventory before you can sell it. That’s when inventory finance and business inventory loans come in, helping retailers invest in stock to generate revenue, even if they don’t have the cash upfront.
Retail cash flow can be complex, with cash tied up in assets (inventory) until it sells. Until that point, that capital is stuck (illiquid) making it hard to buy new stock until the old stock is converted into revenue.
This can be frustrating, but inventory finance and loans, or asset-based lending, solves this problem. It allows retailers to get hold of new capital by using your existing stock as collateral against a loan, enabling them to invest more flexibly in new products.
Here we'll go over the key details you need to know about inventory finance and how to use it in your business.
What is inventory financing?
Inventory financing (also called warehouse financing) is a type of short-term business loan using inventory as collateral to obtain funding.
This can be invaluable in the fast-moving world of retail. Say, for example, you’re gearing up for the busy holiday season. You've identified popular products that are sure to sell, but your current cash reserves aren't enough to stock up since you’re still holding a lot of unsold products elsewhere. This is where inventory financing comes in.
By leveraging the value of your current or to-be-purchased inventory, you can secure a loan to purchase the additional stock needed to meet customer demand.
This can be a game-changer for small businesses, helping them manage their cash flow, respond to demand and prioritise high-value items without waiting for existing inventory to sell.
What's an Inventory Loan?
An inventory loan is a type of secured loan specifically designed to help businesses purchase inventory. Unlike traditional loans, an inventory loan uses the inventory itself as collateral, making it easier for small businesses to get the funding they need to buy new products.
How does inventory finance work?
Most businesses use inventory finance as a way of buying more stock. This could be to fulfil a large order, prepare for an event or get ready for the start of a busy season.
You’ll need to decide how much of your inventory you want to use as collateral and choose a lender that meets your needs – some will charge more or less in fees and interest rates are likely to vary too.
Lenders typically offer a percentage of this value as a loan. For instance, if your inventory is valued at £50,000, a lender might offer you a loan of up to £40,000, depending on their terms. This loan can then be used to purchase new inventory, ensuring your shelves are stocked and your business is ready to meet customer needs.
Once set, you’ll receive your cash and can gradually pay it off as you sell your inventory. After paying it back, you can even choose to take out a new inventory finance loan and start the cycle again, or use a revolving line of credit.
Types Of Inventory Finance: Inventory Loan Vs Inventory Line Of Credit
When it comes to funding your inventory purchases, there are two main types of inventory finance options to consider.
- Short-Term Loans: Short-term business loans provide a lump sum of money that you can use to purchase inventory. These business inventory loans are typically repaid over a shorter period, usually within a year. The rate will depend on the value of the collateral – ie how easy it would be for the lender to recoup their capital if necessary.
- Lines of Credit: Lines of credit offer more flexibility compared to short-term loans. With a line of credit, you are approved for a maximum credit limit and can draw funds as needed up to that limit. You only pay interest on the amount you actually use, making it a versatile solution for managing ongoing inventory needs.
Inventory finance example
Let’s say you run a toy business. It’s September and Christmas is just around the corner. You’re hoping this will be a record year for you and want to build up a large supply of toys before the festive season begins.
You’ve already got some toys in stock and decide to use them as collateral to take out a loan against inventory. This way, you can buy even more despite knowing you won’t start selling them until nearer Christmas. Once you’ve secured your finance, you get to work buying materials and assembling new toys.
As December approaches, sales skyrocket as expected and you begin paying your loan until you’re all square with your lender.
Advantages and disadvantages of inventory finance
Advantages of Inventory Finance
- Inventory finance frees up funds tied up in your inventory, rather than waiting to sell it.
- Since your inventory serves as collateral, there’s no need to put up other business assets or personal guarantees.
- Inventory as collateral makes inventory finance more attainable if you have poor credit or you’re a newer business.
- Inventory loans are typically fast to secure, once approved.
Disadvantages of Inventory Finance
- Inventory finance can come with higher interest rates compared to traditional loans, especially if your business is perceived as high-risk
- The value of your inventory can fluctuate, especially for perishable goods or products subject to market trends. If the value decreases, you might face challenges in repaying the loan.
- Lenders will often only cover a certain percentage of the stock value.
Which businesses benefit from inventory loans?
Business inventory loans are particularly beneficial to businesses that have a pressing need for finance but who may struggle with getting credit elsewhere. Businesses that sell in-store or online can use loans against inventory to borrow with preferable conditions, including better terms and interest rates.
Since the repayment of the loan will depend on your ability to sell the inventory in question, it’s best to use inventory finance for stock that you are confident will sell during the loan term.
How to Apply for an Inventory Loan
Applying for an inventory loan can be a straightforward process if you know what to expect. Here's a step-by-step guide to help you navigate the application process and secure the funding you need to keep your business running smoothly.
- Check the what and how much inventory you need
Given that your inventory is going to be the determining factor for how much you can borrow - start there. In order to justify a loan, you’ll need to be sure it’s something you can sell within the relevant term.
- If using existing stock as collateral, take a look at the value of your current inventory to get an idea of how much financing you might be eligible for.
- If using new inventory as collateral, ensure that it lines up with your sales trends and your latest forecasts.
- Prepare your documents
Once you’ve chosen your strategy, you’ll need the records to back up your application. This includes both your general financial context in your business as well as information on the inventory itself. You’ll need to include:
- Balance sheets for your business
- Recent profit and loss statements
- Business tax returns
- Business bank statements
- Relevant inventory lists
- Inventory management records
- Sales forecasts figures
- Submit your application
Once you’ve got your documentation in order, complete the lender’s application form, providing the necessary information about your business, financial health, and inventory.
Once you’ve attached the necessary documents, including financial statements and inventory records, the lender will review your application, assess the value of your inventory, and evaluate your risk. This can also involve a credit check and an evaluation of your sales history and revenue streams.
Note that this can take some time – especially if it's a first time application - so your lender may ask you to sign an agreement before the due diligence phase to ensure you don’t back out once they've put work into reviewing your application.
- Review your offer
Once you’ve been reviewed and been through due diligence, you’ll receive a preliminary offer with details of the inventory loan. This is your chance to ensure the terms fit your projections for your business. Once you’ve gone through the details, you’ll receive a final offer than you can accept and sign.
Inventory finance alternatives
If you’re looking to secure finance to purchase inventory, an iwoca Flexi-Loan can offer more flexibility and transparency, without the need for collateral.
- With our Flexi-Loan, you could borrow up to £500,000 to invest in new stock, bridge gaps or keep business flowing smoothly.
- Apply in a matter of minutes and hold the money for as long as two years or as little as one day – we’ll never charge you early repayment fees.
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